Cloud – I/O Fund

Prediction: Microsoft Azure To Reach $200 Billion In Revenue By 2028

Posted on September 9, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Sep 05, 2024, 11:03pm EDTForbes on Sep 05, 2024, 11:03pm EDT

The period after the dot-com bubble including the financial crisis of 2008 were difficult years for Microsoft. The stock returned a mere 37% compared to Amazon’s 657.9% in the same time frame and Apple’s 5150%.

Microsoft’s stock greatly underperformed prior to Satya Nadella as CEO. Source: YChartsYCharts

Microsoft’s trajectory changed when Satya Nadella, formally of the Azure division, became CEO in 2014 after working his way up through the company over the course of 19 years to president of the cloud business. The stock is up 1,000% in the ten years since Nadella took the helm using his multi-decade cloud experience to steer a remarkable turnaround from a corporate reputation mired in fighting open-source communities and anti-trust issues. Since Nadella became CEO, the returns in Microsoft’s stock have exceeded Amazon and is tied with Apple, as of writing.

Microsoft’s stock has outperformed since Satya Nadella became CEO in 2014. Source: YChartsYCharts

The competitor Nadella faced in building Azure is arguably the toughest competitor in technology – Amazon Web Services (AWS); not only for the vendor lock-in qualities of cloud IaaS as migrating a tech stack is quite costly in both time and money, but also because AWS had the first mover advantage of a four-year head start. In the tech industry, a lead this long is considered insurmountable.

Over the past ten years, Microsoft strategically exceled by targeting the Fortune 500 with 85% running on Azure today. Retaining the Fortune 500 in the migration to the cloud was accomplished through hybrid computing where Microsoft was first-to-market on serving a mix of on-premise, private and public clouds for their large enterprise customers. As the leader in on-premise systems, Microsoft was perfectly positioned to win with hybrid architectures. The company took this a step further and undercut other services on prices across its suite of software and platforms to win aggregate, long-term contracts.

This past month, for the first time, Microsoft has announced it will be re-organizing its reporting segments, which will afford investors a better apples-to-apples comparison between Azure and AWS. According to Wells Fargo, the new Azure reporting segment stands at an estimated $62 billion as of June 2024, compared to $105 billion for AWS.

The lead we see from Microsoft today on AI revenue streams is critical enough and predictive enough that it points toward Azure surpassing $200 billion by 2028, catalyzed by the OpenAI investment, Copilot’s rapid integration into nearly every Microsoft software product, having the ace of spades — which is an operating system used in 72% of the world’s laptops and desktops, and perhaps the simplest reason of all —- Microsoft excels at the enterprise.

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New Azure Reporting Reveals 11-Points of AI Contribution

Microsoft offers investors unique insights as to the monetization opportunities for AI. Last year, in the FY2023 Q4 report ending in July, Azure officially inflected due to AI. Per the report: “Azure and other cloud services revenue grew 26% and 27% in constant currency, including roughly 1 point from AI services.” In four brief quarters, Microsoft is now reporting an 8% inflection from AI: “Azure growth included 8 points from AI services where demand remained higher than our available capacity.”

Later, it was stated in an updated FY25 investor presentation that Azure saw an 11 point contribution last quarter compared to the 8 points previously reported. The metric change is due to Microsoft removing Enterprise Mobility + Security (EMS) and Power BI (BPP) from Intelligent Cloud. It’s significant that Azure is seeing low double digits while AWS and Google Cloud are not reporting their exact contribution from AI, rather are remaining vague by saying “several billions” in AI revenue.

The reporting changes also update Azure’s growth rate to 33% for the fiscal year and an impressive 35% growth in constant currency. Prior to the metric changes, management guided for a slight deceleration in Azure growth in Q1’25, with growth of 28% to 29% in CC (vs 30% this quarter), yet they expect an acceleration in H2’25 as their capital investments increase AI capacity.

Microsoft Azure recently updated metrics to show higher AI contribution of 11 points. Source: MICROSOFT FY25 INVESTOR METRICS

According to Wells Fargo, the new metrics suggest an annualized run rate for Azure of approximately $62 billion. Investors will get the official number in next quarter’s earnings report.

Management has stated the primary issue is being capacity constrained, which all things equal, is bullish for the medium-term as it implies demand exceeds supply for Azure AI and Azure’s consumption business. Per management in the most recent earnings call: “And in H2, we expect Azure growth to accelerate as our capital investments create an increase in available AI capacity to serve more of the growing demand.”

Azure AI is a platform for developing custom AI applications and solutions. Companies use Azure AI to integrate generative AI and multimodal language models into their applications for features such as search, image recognition, natural language processing, speech to text and other AI features using developer tools, such as APIs and SDKs. The platform also offers lifecycle management for data preparation and model development and training for machine learning, supporting popular frameworks PyTorch and Tensorflow. Azure OpenAI provides access to OpenAI’s GPT-4, GPT-3.5, Microsoft’s DALL-E models, and Meta’s Llama models for companies to build custom generative AI applications and AI assistants. Companies run models on their data to improve workflows through Azure AI Studio.

Azure AI customers totaled more than 60,000, implying customer growth rate of nearly 60% YoY and up over 13% vs Q2’24 with average customer spend continuing to grow. The number of Azure AI customers using data and analytics tools also grew nearly 50% YoY.

Where Azure stands apart is that its security segment is one of the largest in the world. In 2023, it was stated Microsoft’s security segment was at $20 billion with 860,000 customers. The number of customers has been updated to 1.2 million, and if we do some simple math, that would imply the security segment is at $28 billion today – far exceeding all best-of-breed cybersecurity companies combined.

Also tied to Microsoft’s strong presence in security, the Federal Government often gets overlooked in terms of its AI impact to Azure. In a blog post, the company CTO Bill Chappell wrote: "[…] generative AI capabilities through Microsoft Azure OpenAI Service, can help government agencies improve efficiency, enhance productivity, and unlock new insights from their data. Many agencies require a higher level of security given the sensitivity of government data. Microsoft Azure Government provides the stringent security and compliance standards they need to meet government requirements for sensitive data."

Key metrics for Microsoft have been on fire lately. Bookings increased 17% YoY and 19% on a constant currency basis. This was significantly above expectations and driven by growth in the number of $10M+ and $100M+ contracts for Azure and Microsoft 365. This compares to 29% growth (31% on CC basis) in Bookings last quarter and compares to a -2% decrease (-1% on CC basis) in Bookings in the year ago quarter. Commercial RPO grew by 20% YoY to $269 billion. This compares to 20% growth last quarter and 19% YoY growth in the year ago quarter.

Source: I/O Fund Stock ResearchI/O Fund Stock Research

If Azure were to continue its growth rate today on the assumption that any acceleration from AI offsets a deceleration on traditional cloud revenue (due to repatriation from moving cloud workloads to on-prem, for example), then Azure would reach revenue of $178.3 billion by 2028. That’s the bare minimum base case.

If we assume that AI contributes an additional 10 points for the next two years, and then tapers off to 8 points of AI contribution, and finally 4 points of AI contribution due to a higher revenue base, while also offsetting up to a 6-point decline in traditional cloud workloads, then Azure will reach $206.7 billion by FY2028 (ending in June of 2027).

Source: I/O Fund Stock ResearchI/O Fund Stock Research

There are some analysts forecasting $41.6 billion for AI revenue for AWS by 2027. It’s reasonable to assume Microsoft’s AI revenue will be higher as it’s the only company reporting details on AI revenue across the Big 3 and at a double-digit percentage of 11% nonetheless (or about $7 billion in AI revenue) compared to vague comments of “several billions” of AI revenue from Azure’s competitors, and likely to be the $3 to $4 billion range. Therefore, assuming Microsoft has $55 billion in revenue by 2027 compared to AWS’ $42 billion is a reasonable assumption.

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Copilot’s Rapid Integration

While OpenAI’s Chat-GPT and Google’s Bard /Gemini have gotten all of the attention, Microsoft has been quietly building an AI software empire with Copilot. Copilot features are designed to boost productivity and are integrated across consumer and enterprise software, including Windows, Edge, Office, Bing, Teams, Loop, Dynamics and Viva.

Copilot utilizes large language models that require Azure consumption. To prepare for this moment, Microsoft invested $1 billion in Open AI in 2019. Over the last five years, Microsoft has increased its investment to $13 billion. Open AI’s Chat-GPT are some of the large language models that power Microsoft’s Copilot. OpenAI leads the market on LLMs and every time Chat-GPT is integrated into a product and used across OpenAI’s user network, money funnels to Azure as Microsoft is the exclusive cloud provider in exchange for allowing OpenAI to access Azure’s infrastructure at a reduced cost. Around the time that Chat-GPT was noticed by Wall Street, Microsoft’s management team said the following about its impact on Azure:

“Second, even Azure OpenAI API customers are all new, and the workload conversations, whether it’s B2C conversations in financial services or drug discovery on another side, these are all new workloads that we really were not in the game in the past, whereas we now are.”

Developers pay between $10 to $19 per month for GitHub Copilot. According to the most recent earnings report, Copilot accounted for over 40% of GitHub’s revenue growth this year and is already a larger business than all of GitHub when Microsoft acquired it at $2 billion annual recurring revenue (ARR). GitHub Copilot has been adopted by over 77,000 companies, up 180% YoY.

Copilot Studio, a low-code tool for creating and maintaining copilots, saw a 70% QoQ increase in organizations using it to 50,000.

Copilot for Sales and Service is priced at $50 per user each, Copilot for finance is $30 per user, and for Dynamics data platform use cases, it’s priced as high as $1,397 per tenant. The highest cost is Copilot for Security, priced at $4 per hour, with an estimated monthly cost of $2920.

Although some of the upside from Copilot will be reported in other revenue segments outside of Azure, there are some tie-ins regardless of where Copilot is running. For example, enterprises need data to reside where Copilot can access it, which implies higher Azure revenue. On a more granular level, those who subscribe to Office 365 are often locked-in to Azure Active Directory (AD).

Today, Microsoft has more than 400 million 365 Commercial customer seats and 78.4 million 365 Consumer subscribers, giving a nearly ~480 million customer base to target for AI services. Assuming AI PCs help to spark a strong growth trajectory for Copilot, just a 10% adoption rate across both Commercial and Consumer by the end of the fiscal year would surpass $17 billion annual run rate. It’s likely the 10-year adoption rate will be well above 50% with an addressable market of up to 90% as more AI assistant productivity hacks are developed. This means Office 365 would land somewhere between $86 billion and $156 billion, equal to the current size of Azure or up to double the size of Azure on this revenue stream alone.

While Wall Street is worried about how much AI is costing, the I/O Fund is busy calculating how big the AI opportunity can get in the next few years and how investors can participate. Join our next webinar on Thursday September 12th where the Portfolio Manager will discuss potential entries for Microsoft and other AI-related stocks.our next webinar on Thursday September 12th where the Portfolio Manager will discuss potential entries for Microsoft and other AI-related stocks.

Copilot for Microsoft 365 is priced at $30 a month. The productivity tool combines large language models (LLMs) with the data in Microsoft Graph and Microsoft 365 apps. The use cases of Copilot in Word include giving users the first draft while saving the time on sourcing, writing, and editing the content. Similarly, Copilot in PowerPoint will help to create presentations based on previous content. Copilot in Excel can analyze trends from the data, create charts, and assist in making informative decisions.

In the second full quarter of availability, the number of people using Copilot for Microsoft 365 nearly doubled QoQ. Copilot customers increased 60% QoQ and the number of customers with over 10,000 seats more than doubled QoQ.

Power Platform, a collection of low-code development tools, saw MAUs rise 40% YoY to 48 million. 480,000 organizations have also used the AI-powered capabilities in Power Platform, up 45% QoQ. As stated, Power Platform will no longer be reported in Microsoft’s Azure segment

Copilot on the Verge of Becoming Ubiquitous

Windows operating system is in 72.3% of desktop and laptops. When you consider that Windows has most recently launched on an Arm-based PC with Qualcomm, and will also launch next year with AMD and Nvidia, that market share is likely to grow rather than contract. Similar to the penetration rate of Office 365, Windows dominates PCs regardless if the OEM is Dell, HP, Lenovo, Acer, Asus, LG, Samsung or Microsoft Surface.

Copilot+ for Windows is a sidebar that helps Windows users change settings, find files or summarize text across a desktop. Recall is a feature that helps a Windows user find documents, emails and web pages when a user simply states how they recall the file or digital asset. On some Surface laptops, there is a Copilot key, a digital pen enhanced with AI, sound and voice features enhanced with AI, and enhanced AI cameras.

Both Arm-based and x86 AI PCs are ramping this year with a CPU + GPU + NPU combo that will, in turn, proliferate Copilot+ for Windows, the AI assistant that requires a minimum of 40 TOPS (trillions operations per second). The neural processing units (NPUs) are powerful enough to deliver the official kickoff of AI edge computing as Copilot+ runs AI tasks locally on the AI PC and integrates them into various applications. This is an important moment for AI as prior to NPUs exceeding 40 TOPS, workloads were primarily sent to the cloud. By running AI assistants locally on the computer, suggestions will be faster and more accurate.

Qualcomm’s Snapdragon X Elite and Plus processors were released this last summer and offer the first GPU, CPU and NPUs that exceed 45 TOPS for AI tasks for Microsoft’s Copilot+ with a long battery life of over 12 hours. This week, Intel released its second-generation Core Ultra chips capable of reaching 48 TOPS that offers a long battery life of over 10 hours with the added benefit of running legacy x86 software without compatibility issues.

Canalys is projecting AI PC shipments to rise at a 44% CAGR from 2024 to 2028, from an estimated 48 million PCs this year, before doubling to more than 100 million in 2025 and rising to over 205 million by 2028. Cumulative shipments of AI PCs are projected to surpass 600 million over the next four years. I’ve covered additional information on the growth of the AI PC market here.

Within this rapid growth, commercial adoption is forecast to be higher, at approximately 60% by 2028 versus 40% for consumer. This is due to the productivity gains that AI PCs can enable via powerful on-device AI as well as benefits to software developers and related roles. For example, Dell’s XPS and Latitude 7455, equipped with the Snapdragon X Elite can support 13 billion-plus parameter models which means customers can run popular models like Llama 3 directly on their PCs. The fact that commercial adoption will be higher than consumer adoption is a boon for Microsoft Copilot and its suite of enterprise AI-enabled applications and platforms.

Microsoft’s Capex Spending Highest Among Cloud IaaS Providers

Microsoft is unabashedly spending tens of billions on AI infrastructure. In the last earnings report, the company announced strong QoQ increase to its capex for AI infrastructure. Capex was $14 billion last quarter, when it grew 22% sequentially. Microsoft’s capex increased 36% sequentially and 78% YoY to $19 billion in Q4.

Full year 2024 capex was up 75% YoY to $55.7 billion, yet this quarter’s run rate suggests we could see up to $80 billion in capex in FY2025. Compare this to cloud IaaS leader AWS which reported H1 capex of $30.5 billion for a run rate in capex of just over $60 billion. Notably, management is guiding for a further YoY increase in capex in FY’25. I have covered the importance of Big Tech’s capex for AI stocks in an analysis here and also in a previous webinar.an analysis here and also in a previous webinar.

Big Tech management teams have been getting an earful from Wall Street on when investors can expect to see a return. Private investors are busy calculating what level of revenue these companies must generate, estimating the return will need to be as high as $600 billion to justify the revenue Nvidia has reported in its data center segment.

Therein lies the disconnect, which is that Microsoft’s CFO, Amy Hood, states they are capacity constrained – implying the opposite problem, that the capex they’ve allocated is not nearly enough to serve Azure AI demand. Per the last earnings call: “We are – and we've talked about now for quite a few quarters, we are constrained on AI capacity. And because of that, actually, we've, to your point, have signed up with third parties to help us as we are behind with some leases on AI capacity. We've done that with partners who are happy to help us extend the Azure platform, to be able to serve this Azure AI demand. And you do see us investing quite a bit as we've talked about in builds so that we can get back in a more balanced place.”

Microsoft’s management team also pointed out about 40% of capex is spent on land, which is a long-term asset, and the rest is tied to a demand signal for inference. The CFO stated: “even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal.”

Therefore, investors have an important decision to make. On one hand, investors could listen to the bearish undertones that high capex spending will not be returned to investors over time, or on the other hand, view high capex spending as a bullish signal of the overflow in demand that will sustain for many years to come, with AI consumption well exceeding the capex being spent to build the infrastructure.

Conclusion:

In 2022, I wrote an 8,300 word analysis entitled Special Report: The New Kings of Tech for our research members that tied together key points on how to position our readers for AI’s big moment – well in advance of Nvidia’s stock surge. Part of this analysis was to emphasize that our readers should shift their mindset from consumer-facing stocks to enterprise-facing stocks. This is not easy to do given the FAANGs are primarily consumer stocks, and it was consumer that drove historic gains for the market over the past decade.

Here is what I wrote at the time:

“The adage is that history rhymes but it does not repeat. I believe a large addressable market is certainly required to produce the new wave of FAANGs – however, rather than consumer driving the gains, I believe it will be enterprises. Below, I discuss the enterprise-level market that will be four times larger than mobile and two stocks that will directly participate. Imagine participating in 4X the FAANGs by 2030. That’s what I believe will happen due to one key trend and I discuss exactly why this will be achieved below.” -I/O Fund’s Special Report: The New Kings of Tech, June 5th 2022

Nowhere will the AI enterprise advantage be more evident than with Microsoft’s steady ascent over the next ten years, which I believe will end with Microsoft firmly on top in nearly every category the company competes in. A few years ago, I predicted Nvidia would Surpass Apple by 2026. At the time, Nvidia had a $550B market cap and the mere thought was inconceivable . To that point, I purposely did not say Nvidia would surpass Microsoft — as once the AI opportunity fully plays out —- this company will be a tough one to catch.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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AI Driving Acceleration For Big 3 Cloud Stocks

Posted on February 13, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Forbes Forbes on Feb 8, 2024,07:01pm EST

Big Tech’s participation in the market’s push to all-time highs is becoming increasingly narrow, with Nvidia, Meta, Microsoft and Amazon serving as the primary contributors to 2024’s rally. Though Alphabet fell more than 7% on somewhat disappointing Google ad revenue, Alphabet’s Google Cloud, Microsoft’s Azure, and Amazon’s AWS shined as generative AI products drove an acceleration in cloud revenue growth in the recent quarter.

Source: Trading View

The Big Three’s cloud segments are crucial to business performance on both the top and bottom lines: Azure sits as Microsoft’s fastest growing segment (excluding Xbox’s more than 40 percentage point impact from Activision in Q2), AWS is driving a lion’s share of Amazon’s operating income, while Google Cloud is now generating more than 10% of revenue as Alphabet’s fastest growing segment while expanding its operating margin.

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Microsoft’s Azure

Azure witnessed the strongest AI contribution by far, as Microsoft works to extend its lead as the first major tech player to monetize enterprise and consumer AI subscriptions at scale. Azure also is powering a handful of the largest LLMs and AI assistants on the market, from OpenAI’s ChatGPT to Meta’s Llama and Llama 2 to Microsoft’s own Bing Copilot.

We highlighted in October in our free newsletter that AI would help drive a ‘noticeable acceleration’ for Microsoft’s revenue this year, and that’s exactly what we’re seeing: revenue growth accelerated from 8.3% YoY in fiscal Q4 2023 (calendar Q2) to 17.7% YoY in fiscal Q2 2024 (calendar Q4).

Azure growth was 30% in fiscal Q2, a 200 bp QoQ acceleration driven by strong demand for consumption-based services. Yet AI’s impact was quite notable: Microsoft said the 30% growth rate for Azure included “6 points from our AI services.”

Source: Microsoft

This 6 point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4 — a significant ramp considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate. This AI-related growth has helped Azure’s growth re-accelerate after seeing decelerating growth for five straight quarters.

Azure’s AI customer growth has also been rapid, and Microsoft is seeing an increase in larger commitments for Azure. Microsoft reported that Azure AI customers totaled more than 53,000 last quarter, with one-third of these new customers over the past twelve months. That implies customer growth rate of approximately 50% YoY, given that Microsoft added nearly 18,000 customers through 2023. More than half of the Fortune 500 are using Azure OpenAI Services, highlighting the strength of Microsoft’s AI offerings.

For Azure specifically, management said on the earnings call that “customers continue to choose Azure to simplify and accelerate their cloud migrations. Overall, we are seeing larger and more strategic Azure deals with an increase in the number of $1 billion-plus Azure commitments.” An increase in customer count and an increase in deal size are foundations for sustainable long-term growth and supportive of further acceleration in the coming quarters.

Amazon’s AWS

Q4 was a busy quarter for Amazon as it rolled out many new features, capabilities and hardware designed to capture generative AI demand, with AWS showing a hint of accelerated growth. AWS finally accelerated in Q4 for the first time in 2 yearsQ4 for the first time in 2 years, with Amazon reporting 13.2% growth in Q4, up just over 1 point from Q3’s 12%. AWS is now quickly approaching a $100 billion annual run rate, delivering $24.2 billion in revenue in Q4 and $90.8 billion in revenue for 2023.

What’s more important is that AWS’ operating leverage has improved over the last two quarters, with operating income growing at 3x the rate of revenue in Q4.

Source: Amazon

AWS’ operating income increased 39% YoY on a constant currency basis in Q4, with operating margin increasing 530bp YoY to 29.6%. For the full year, AWS’ operating margin was 27.1%, down 140bp YoY as operating leverage decreased in the first half of the year as growth decelerated from the 20% range to the 12% range.

AWS remains Amazon’s primary generator of operating income (67% of Amazon’s total operating income in 2023), a trend that can strengthen with AI driving accelerated customer and revenue growth and decreased costs. CEO Andy Jassy explained that AWS “added more than $1.1 billion an incremental quarter-over-quarter revenue, which on an FX neutral basis is more than any other cloud provider as far as we can tell.”

AWS’ existing customers “are renewing larger commitments over longer periods and migrations are growing,” and “while cost optimization continued to attenuate larger new deals also accelerated.” That includes recent agreements with Nvidia to be the first CSP to deploy the GH200 Grace Hopper Superchips with multi-node NVLink technology, and with Salesforce to deepen AI and data integrations between the two.

Bedrock is already witnessing strong adoption, with management seeing “many thousands of customers using the service after just a few months” as AWS continues to add “new models from Anthropic, Cohere, Meta with Llama2, Stability AI and our own Amazon Titan family of LLMs.”

Although AWS’ quarterly growth rates look paltry compared to Azure’s 30% and Google Cloud in the high-20% range, it is still showing all the ingredients for a sustained AI-driven acceleration.

Google Cloud

Google Cloud revenue accelerated four points from 22% in Q3 to 26% in Q4, topping $9 billion for the first time, helped by an increasing contribution from AI. Q4’s $9.2 billion in revenue implies that Google Cloud is just crossing above a $36 billion annual run rate, less than half of Azure’s run rate and 60% below AWS’ $90 billion run rate.

Google Cloud’s operating margin in Q4 came in at 9% compared to 3% in the previous quarter and (0.2%) in Q4 last year. Margins are naturally worse than AWS and Azure as Google Cloud does not benefit from the same efficiencies at scale; however, it is positive to see strong QoQ and YoY improvement in operating margin as it bodes well for future performance at a larger revenue scale.

Source: Alphabet

This acceleration in Q4 also helped narrow the gap to 4 percentage points with Azure, compared to 7 percentage points in the previous quarter. Google Cloud had previously topped Azure’s growth rates in late 2022 and the first half of 2023 before a rather swift deceleration in Q3. What’s crucial here over the next few quarters is Google Cloud continuing to close this growth rate gap with Azure, and possibly surpass Azure once more — it should be theoretically easier to realize higher growth rates at a smaller scale, more so when leveraging AI.

Like AWS and Azure, Google Cloud is seeing strong momentum with AI products. Management said that the “strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area,” while its generative AI portfolio helped win and expand deals. CEO Sundar Pichai said that “greater than 70% of gen AI unicorns are using Google Cloud,” and customers including Anthropic and Mistral AI are building and serving LLMs on Google Cloud’s AI Hypercomputer, which combines Google’s “TPUs and GPUs, AI software and Multislice and Multi-host technology to provide performance and cost advantages for training and serving models.”

Google Cloud led the charge in monetizing AI via subscriptions with Duet AI for $30/month, and management noted that customers are “increasingly choosing Duet AI” to “boost productivity and improve their operations.” Duet AI will soon incorporate Google’s Gemini, its multi-modal family of LLMs developed to challenge OpenAI’s GPT-4. Google Cloud is “intensely focused on bringing the benefits of Gemini” to its cloud customers, and the rollout of the top iteration, Gemini Ultra, at a $20/month subscription could help Google gain share away from OpenAI and thus Azure while increasing revenue.

Conclusion

Big Tech’s cloud units reported strong growth in calendar Q4, with AI helping drive a noticeable acceleration for Azure while AWS and Google Cloud touted strong contributions from generative AI products. The trio all possess the necessary ingredients for sustained accelerations or maintained growth at higher levels: increased customer migrations, larger and longer duration contracts, monetization opportunities within the suite via subscriptions, and improvements in productivity and cost reductions for cloud customers.

I/O Fund Equity Analyst Damien Robbins contributed to this analysis.

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Bitcoin and Microsoft Positions Update

Posted on January 20, 2024June 30, 2026 by io-fund

The below 2-week chart in Bitcoin has been quite accurate at identifying the cycles that have caused a trend change. This chart shows the next two cycles as April 10 – 25, and June 7 – 2. What will matter the most here is how we trend into these time factors. I'm forecasting that we see weakness into one of these regions. It also shows the levels (on the right) where we will be layering in. We will set up limit orders for these buys, 2% at each level. BTC trades 24/7 and loves to spike and reverse at lows. So, we've found limits are the best answer for this. This means that you may receive a trade notification on Sunday morning from a limit that hit while we were sleeping. So, be prepared for that.

The below chart shows the bigger counts I'm tracking. The blue count is my primary. Here, we will see a multi-week/month drop into the $35K – $27K region (likely into one of the time factors listed). My backup is the green count, which has us in a 4th wave of a larger 3rd. This will bottom between $40K – $38K, hence our buying at these regions. I don't know what count will play out. The cycle work suggests the blue. However, if we are in a 3rd wave, expect to be left behind with shallow pullbacks. So, we will keep layering in at each support zone. The red count will be taken more seriously if we see a 5 wave drop below $34,800. If this happens, and it is followed by a 3 wave retrace, be prepared to exit crypto.

Microsoft

MSFT hit our first target at $395. We are now in a 5th of a 5th of a 5th of a 5th wave. It's best to wait and see how we correct and if we break below $370.

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Palantir, Three Other Cloud Stocks Poised For An Acceleration In 2024

Posted on December 19, 2023June 30, 2026 by io-fund

This article was originally published on Forbes on Dec 14, 2023,10:42pm ESTForbes Forbes on Dec 14, 2023,10:42pm EST

Cloud stocks have been a mixed bag for investors heading into the end of the year, as a handful of names — Confluent, Sprinklr, HashiCorp, Bill, Paycom — plunged following their earnings reports with growth set to slow, while others — Datadog, Elastic, Salesforce – soared on renewed optimism about AI prospects.

Overall, cloud has lagged broader tech’s rally this year, and on a 3-year basis, returns are still negative, compared to a 27.4% gain for the QQQ. Many cloud darlings in 2020 and 2021 remain far below those highs – take Fastly, for example, where quarterly growth has slowed from the 40% range to the teens, with shares nearly (-80%) lower.

Source: I/O FUND

2023 was a stock picker’s market, and 2024 likely will be as well, with revenue growth rates for a majority of the sector set to slow. Only a few cloud stocks are expected to see revenue growth rates accelerate in 2024. We detail for you the four stocks set to accelerate below.

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Palantir

Palantir is one of the Street’s AI favorites this year with a 179% YTD return. The company is exhibiting multiple signs of acceleration heading into 2024 with an improved fundamental backdrop driven by increasing AI demand. Palantir’s Artificial Intelligence Platform (AIP) is driving a significant acceleration in its US commercial business, while underlying metrics and the bottom line are rapidly improving: Palantir posted its first GAAP profitable quarter in February and has since reported four consecutive GAAP profitable quarters.

Customer and US commercial customer growth remains solid, growing 34% and 37% YoY respectively in Q3. CRO Ryan Thomas noted that the US commercial business accelerated in Q3, and excluding strategic commercial contracts, it grew 52% year-over-year and 19% sequentially. Total contract value in the segment increased 55% year-over-year on a dollar-weighted duration basis, with an “acceleration of larger deals and shorter times to conversion and expansion.” He attributed this growth partially to the AI Platform, as the “rapid expansion of AIP at both our existing and new customers, and the impact it is having on their operations is nothing short of remarkable.”

The AI Platform’s growth since its launch in June has also been remarkably strong, with Palantir nearly tripling the number of users in the past quarter, with over 300 organizations using the product in 5 months. Palantir’s profitability is allowing it to continue to “more aggressively invest” in the AI Platform without sacrificing margins, a key differentiator from a majority of cloud AI plays, who are investing in growth at the expense of margins.

Fundamentally, Palantir is becoming stronger. GAAP gross margin expanded above 80% for the first time in Q3, GAAP operating margin has expanded to 7.2%, and GAAP net margin has risen to 12.8%. Palantir’s EBITDA margin also reached 16% in Q3, its first quarter with a double-digit positive margin, while adjusted free cash flow margin reached 25%. Margins have expanded sequentially in both Q2 and Q3, so the next hurdle will be showing further expansion in Q4 to set up for an increasingly positive trajectory in 2024.

Source: I/O FUND

Revenue growth is poised to accelerate in Q4 and through 2024, boosted by AI demand, a reacceleration in Palantir’s US government segment, and continued strength in the US commercial segment stemming from the Artificial Intelligence Platform. Palantir is currently projected to report 18.5% YoY growth in revenues in Q4, the highest in five quarters, pulling 2023’s full-year revenue growth rate up to a projected 16.5%. 2024 is expected to see an acceleration, with current projections pointing to a 320 bp acceleration in Palantir’s revenue growth rate to 19.7% YoY.

Source: SeekingAlpha

Palantir’s underlying metrics support the revenue reacceleration story, but the stock is by no means cheap at 14.2x 2024 EV/revenue and approximately 52x 2024 operating cash flow. Palantir also noted in Q3 that its net dollar retention rate was 107%, with adverse impacts from its European commercial business. This presents a risk that a land-and-expand strategy places more emphasis on signing more customer deals each quarter, and a slowdown in customer additions raises the risk that the expected revenue acceleration won’t pan out as projected.

Shift4 Payments

Payments processing firm Shift4 Payments is not a traditional cloud stock, but it has seen significant momentum within its cloud product, SkyTab, alongside positive momentum in a land-and-expand model for its software offerings. Shift4’s recent M&A activity with Appetize and Finaro are expected to significantly contribute to revenue and EBITDA, playing a role in its 1140 bp projected revenue growth acceleration from 31.3% this year to 42.7% in 2024.

Shift4 says it is currently “in the midst of a very successful consolidation” of SkyTab POS, with some of the success owing to a significant total cost of ownership (TCO) advantage relative to competitors. Shift4 installed 8,254 SkyTab systems in Q3, or more than 35% of its cumulative install volume since its launch. Bringing existing customers over to SkyTab boosts ARPU as it is resulting in higher subscription fees per merchant.

Finaro and Appetize’s acquisitions are expected to be accretive to revenue and EBITDA growth starting this quarter and expanding in 2024. Combined, the two are expected to contribute nearly $25M in gross revenue less network fees and $6M in EBITDA in Q4. With Finaro in particular, Shift4 is expecting “a very strong Q4 ahead” as “numerous enterprise accounts have begun processing.”

Financially, Shift4 is the strongest of the four, hitting records across a majority of its metrics, from end-to-end payment volumes, revenue, gross profit, and margins. Gross profit rose 34% YoY to $171M and reached a record 26.7% margin, leading to more operating leverage down the line as operating margin expanded to a record 7.9%, up 490 bp YoY. Net margin improved for a second straight quarter to 4.8%, though it remained 310 bp lower relative to a peak at 7.9% in Q3 last year. Adjusted free cash flow grew 69% YoY to $75.5M.

Source: I/O FUND

In 2024, revenue growth is forecast to be >40% YoY in each quarter, from ARPU expansion from SkyTab, net new merchant additions, and contributions from M&A synergies. This represents a rapid acceleration after a four-quarter deceleration, with quarterly revenue growth rates back to levels seen in 2022. However, the main risk to this case is that a pretty swift deceleration is projected in 2025, with revenue growth dropping back to the 28% range. A more uncertain macro backdrop may create some headwinds in 2024 and lead to early signs of a deceleration sooner than expected in late 2024 or 2025.

AvePoint

AvePoint provides cloud migration, management, and data protection solutions primarily for Microsoft 365, with a suite of products and AI/ML offerings for both cloud and hybrid/on-prem workloads. CEO TJ Jiang is aiming for the company to become a “key enabler of generative AI adoption within enterprises in the coming years,” as he believes AI “will drive a wave of enterprise transformation across all industries.”

Generative AI “obviously is playing a part into the future quarters,” according to Jiang. The launch of Microsoft’s Copilot AI assistant for enterprise 365 users serves as a major tailwind for 2024. This boost, alongside a continued shift to the cloud in Microsoft Office’s commercial customer base, is underpinning an expected 70 bp acceleration in revenue growth to 16.4% in 2024 before a stronger 330 bp acceleration in 2025 to 19.7% growth.

Customer expansion can also help this acceleration pan out, especially if advanced talks with large customers can translate to expanded deal sizes in Q4 and early 2024: AvePoint is in talks with a long-time customer to accelerate their cloud migration, another customer is in “advanced talks” to purchase AvePoint’s Opus solution, and a UK customer is considering expanding the scope of their deployment of AvePoint’s Secure Backup Service Solution.

Source: I/O FUND

AvePoint’s financials are improving, though it is not yet GAAP profitable, reporting a GAAP operating loss of ($0.3 million) in Q3, or a margin of (-0.4%). GAAP net margin was (-5.8%), a solid improvement from the (-12%) to (-24%) range reported over the last six quarters. EBITDA margin was 1.2%, the first positive quarter; moving forward, AvePoint needs to keep improving these metrics and post consecutive quarters with positive EBITDA and move closer to GAAP profitability on the bottom line.

Source: I/O FUND

However, there is one red flag, and that’s in AvePoint’s ARR. ARR growth has been decelerating, from the high 30% range in 2021, to 23% in Q3, and now to a guided 22% YoY in Q4 to $262M. The bull case will be looking for this to bottom in Q4, and the company’s history of raising guidance each quarter this year suggests Q4’s ARR growth could come in slightly above the guide at 23%. In addition, Q4’s net new ARR guide is pointing to a sequential decline to ~$11.4M, but management clarified that this stems partially from macro headwinds but also from a spike in government strength and subsequent revenue pull-forward in Q3.

Source: I/O FUND

This guided sequential decline in net new ARR raises another hurdle for the bull case – a resumption of sequential growth in net new ARR in Q1 and Q2 next year will support this view for revenue acceleration. A further deceleration in net new ARR or ARR will raise the risk that revenue growth fails to accelerate YoY.

AvidXchange

Accounts payable automation and payment solution provider AvidXchange rounds out the list with a minimal 30 bp revenue growth acceleration from 18.6% in 2023 to 18.9% growth in 2024. AvidXchange has posted nine consecutive quarters exceeding its guided outlooks, and this momentum adds a layer of confidence to the acceleration story since a few key metrics continue to decelerate.

Healthy top of funnel growth and a partnership with AppFolio coming online in Q1 next year are two growth levers driving revenue growth higher. AppFolio’s partnership could help drive a reacceleration in transaction volume and payment volume, as AvidXchange will be the first AP application solution in AppFolio with access to more than 19,000 customers.

Fundamentals are improving, but similar to AvePoint, AvidXchange is not yet GAAP profitable. GAAP gross margin is steadily expanding, and is now nearing the 70% level after crossing the 60% threshold in Q1 2022. GAAP operating and net margins improved significantly, by more than 1200 bp sequentially. However, AvidXchange does not yet have the operating efficiency nor leverage to take last quarter’s GAAP net margin of (-8.7%) to GAAP profitability within a few quarters.

Source: I/O FUND

Revenue growth is expected to bottom in Q4 and then accelerate in each quarter next year. Q4’s guide is implying a 500 bp sequential slowdown, so the challenge will be quickly bouncing back to >18% revenue growth. However, this acceleration story comes with two main risks – decelerating growth in both TPV and processed transaction volume. Both metrics have decelerated rather sharply, and have not yet shown signs of stabilizing or reaccelerating.

Source: I/O FUND

Conclusion

Cloud has proven to be a very volatile sector over the past few months. Multiple companies have seen 20% or larger moves in either direction following earnings as investors praised hints of accelerating growth or slammed decelerating metrics. Only a handful of cloud stocks are expected to see revenue growth accelerate in 2024 based on current estimates, and only two of the four covered here have substantial near-term tailwinds from AI, but all are seeing steadily improving fundamentals with a handful of intact growth levers for 2024.

Missing expectations is a risk to any of the four, but more so for AvePoint and AvidXchange given that their expected acceleration is minimal. Palantir’s near 200% YTD surge has been warranted because of a shift to GAAP profitability, but its valuation remains expensive and at risk if growth slows slightly. Shift4 arguably holds the strongest fundamental picture of the four, but a higher degree of risk stems from a quick return to decelerating revenue growth in 2025.

I/O Fund Equity Analyst Damien Robbins contributed to this analysis

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Cloudflare 3Q23 Earnings Summary

Posted on November 3, 2023June 30, 2026 by io-fund

Cloudflare reported revenue and EPS above consensus. However, 4Q23 revenue guidance missed consensus by ~1% due to geopolitical uncertainty and macro headwinds. The other positive thing to note was that Dollar-Based Net Retention Rate (DBNR) improved to 116% for 3Q23. Management believes DBNR will stabilize near these levels and it will take some time for its efforts to improve Go-to-Market execution to be shown in DBNR, which we see as a positive.

Despite the same macro headwinds that Cloudflare is facing along with other software companies, we believe there is strong demand and need for Cloudflare’s products such as Area 1 and its developer platform, Cloudflare Workers. Longer term, we believe NET will significantly benefit from the AI inference opportunity, which we previously highlighted in our Cloudflare: Bringing AI Inference to the Edge note. Currently NET has inference optimized GPUs in 75 cities globally as of the end of October 2023 and is on track to be in 100 cities by end of CY23.

Revenue and EPS

Revenue: $335.6 (up 32% Y/Y) above consensus of $330.6M (+30% Y/Y).
Non-GAAP EPS: $0.16 above consensus of $0.10
NET gave 4Q23 revenue guidance of $352.5M, at the midpoint below consensus of $356.3M (+30% Y/Y)
· Commentary from call: “Moving onto the guidance for the fourth quarter and the full year, with broadening geopolitical uncertainty and increasingly mixed macroeconomic data points across geographies. The business environment in which we operate remain challenging to predict, and as a result, we continue to remain prudent and cautious in our outlook for the fourth quarter”.
Non-GAAP EPS guide: $0.12 above consensus of $0.10.

Margins

Non-GAAP Gross Margin: 78.7% vs. 78.1% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Gross Margins expanded from 77.7% to 78.7%
Non-GAAP Operating Margin: 12.7% vs. 5.8% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Operating Margin expanded from 6.6% to 12.7% due to OpEx as a % of revenue going down 5% Q/Q and going down 6% Y/Y to 66% of revenue.

Cash Flow

$34.9M (10% FCF Margin) vs. ($4.6M) (-2% FCF Margin) in 3Q22
· From 2Q23 to 3Q23, FCF Margins expanded from 6% to 10%
· Commentary from call “This is a business that can generate significant cash, and in 2023, we expect we will generate more than $100 million in free cash flow, well ahead of our original goal when we started the year, and the direct result of improved execution across our entire business.”
· Network CapEx: 8% of revenue.
· FY23: expects network CapEx to be 8-10% of revenue vs. 10-12% previously. However, they expect network CapEx to return to normalized levels over a period. We had highlighted earlier in our analysis that network CapEx is the primary reason why FCF can be minimal at times.

Key Business Metrics

Paying customers: 182,027 (+17% Y/Y)
· Commentary from call: “We added a record number of net new customers year-over-year, spending more than $500,000 and $1 million on an annualized basis with Cloudflare”.
Paying customers with more than $100K ARR: 2,558 (+34% Y/Y)

Dollar-Based Net Retention (DBNR): 116%
· Commentary from call: “We continue to believe the recent decelerating trend in DNR stabilizing near these levels”.

DBNR expanded from 115% in 2Q23 to 116% in 3Q23.

Go-To-Market (GTM)

NET’s pipeline close rates held firm.
· Commentary from call: “During the quarter, the pipeline generated by this new cohort was 1.6 times higher than those brought on at the same time a year earlier. These new account executives achieved more than 130% of their activity goals for the quarter”.
NET’s salesforce productivity remained stable and linearity in terms of when deals were closed was similar to Q2.
· Commentary from call: “I think that we have been able to hold things steady while making significant organizational changes and improvements across our sales and marketing organization is very encouraging. Beyond that, we’re beginning to see positive early signs from the sales team members we’ve brought on over the six months to replace underperformers.”

Conclusion

Cloudflare may require more than one entry. Cloud has been volatile, and NET can produce choppy reports. We plan to use technical analysis to its fullest.

Recommended Reading:

Microsoft Q3 FY23: Strong earnings report

Posted on April 27, 2023June 30, 2026 by io-fund

Microsoft’s Q3 FY23 revenue grew 7% YoY and 10% in constant currency to $52.9 billion. EPS came at $2.45 and was up 10% YoY and 14% in constant currency. The company beat revenue estimates by 3.6% and EPS estimates by 9.6%.

Azure grew by 31% YoY in constant currency and came at the higher end of the management guidance of 30% to 31%.

The management guidance for Q4 FY23 is $54.85 billion to $55.85 billion, representing a YoY growth of 6.7% at the mid-point. It was better than the consensus analyst's YoY growth estimate of 5.9%.

Financials

The company’s revenue in the recent quarter was better than the management guidance across all three segments. Revenue grew by 7% YoY and 10% in constant currency to $52.9 billion. The management guidance was between $50.5 billion to $51.5 billion.

Gross profit grew by 8.8% YoY to $36.73 billion. The gross margin was 69.5% compared to 68.4% in the same period last year. It was also higher than the management guidance of 69.1%. The management guidance for the next quarter is 69.5%. Amy Hood, CFO of the company, said in the earnings call, “Microsoft Cloud gross margin percentage increased roughly 2 points year-over-year to 72%, a point ahead of expectations driven by cloud engineering efficiencies. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage decreased slightly, driven by lower Azure margin.”a point ahead of expectations driven by cloud engineering efficiencies. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage decreased slightly, driven by lower Azure margin.”

Operating income grew by 9.8% YoY to $22.35 billion. The operating margin was 42.3% compared to 41.3% in the same period last year. It was higher than the management guidance of 40.2%. The management guidance for the next quarter is 42.1%.

Net income grew by 9.4% YoY to $18.3 billion. The net profit margin was 34.6% compared to 33.9% in the same period last year. EPS was $2.45 compared to $2.22 in the same period last year and beat estimates by 9.6%.

The operating cash flow came at $24.44 billion, with an operating cash flow margin of 46.2% compared to 51.4% in the same period last year. The operating cash flow included the TCJA R&D tax payment of $1.15 billion and the operating cash flow margin, excluding the tax payment is 48.42%. The free cash flow was $17.83 billion with a free cash flow margin of 33.7% and adjusted excluding the tax payment is 35.9% compared to 40.6% in the same period last year. The company has a stable balance sheet with cash and investments of $104.43 billion and a debt of $48.2 billion.

The commercial remaining performance obligation increased by 26% YoY to $196 billion. Roughly 45% is expected to be recognized in revenue in the next 12 months, up 18% YoY and the remaining portion that will be recognized beyond 12 months grew by 34%. The commercial remaining performance obligation increased by 29% YoY to $189 billion in Q2 FY23.

Segments:

The Productivity and Business Processes segment grew by 11% YoY to $17.5 billion and was better than the mid-point of the management guidance of 8%. The guidance for the next quarter is between $17.9B to $18.2B, up 8.7% YoY at the mid-point.

The Intelligent Cloud segment grew by 16% YoY to $22.1 billion and better than the mid-point of the management guidance of 14.7%. Guidance for the next quarter is $23.6B to $23.9B, up 13.6% at mid-point. Microsoft Azure grew by 31% YoY in constant currency and came at the higher end of the management guidance of 30% to 31%. Azure grew by 38% in CC in Q2 FY23 and 49% in the same quarter last year. The management guidance for the next quarter is 26% to 27% in constant currency, which includes roughly 1% from AI services.

Satya Nadella also highlighted Azure gaining market share and the opportunities in AI. He said in the earnings call, “Azure took share as customers continue to choose our ubiquitous computing fabric from cloud to edge, especially as every application becomes AI-powered. We have the most powerful AI infrastructure and it’s being used by our partner, OpenAI, as well as NVIDIA and leading AI start-ups like Adept and Inflection to train large models.”“Azure took share as customers continue to choose our ubiquitous computing fabric from cloud to edge, especially as every application becomes AI-powered. We have the most powerful AI infrastructure and it’s being used by our partner, OpenAI, as well as NVIDIA and leading AI start-ups like Adept and Inflection to train large models.”

Amy Hood, the CFO of the company, also highlighted the strong growth in AI. She said in the earnings call, “In our largest quarter of the year, we expect customer demand for our differentiated solutions, including our AI platform and consistent execution across the Microsoft Cloud to drive another quarter of healthy revenue growth. Last year, we had our largest commercial bookings quarter ever with a material volume of large multiyear commitments.”

“On that comparable, we expect growth to be relatively flat. We expect consistent execution across our core annuity sales motions with strong renewals and continued commitment to our platform as we focus on meeting customers' changing contract needs, which include shorter term, quick time to value contracts in this dynamic environment. Our key focus remains on delivering customer value.”

More Personal Computing declined by (9%) YoY to $13.3 billion and was better than the mid-point of the management guidance for a decline of (16.7%). The PC segment revenue witnessed better than expected results in all businesses. The guidance for the next quarter represents a YoY decline of (5.6%).

Amy Hood said in the earnings call, “Windows OEM revenue decreased 28% year-over-year and Devices revenue decreased 30% and 26% in constant currency, both ahead of expectations. We saw better-than-expected PC demand, as noted earlier, particularly in the commercial segment, which has higher revenue per license, although results continue to be negatively impacted by elevated channel inventory levels.”We saw better-than-expected PC demand, as noted earlier, particularly in the commercial segment, which has higher revenue per license, although results continue to be negatively impacted by elevated channel inventory levels.”

“Windows commercial products and cloud services revenue increased 14% and 18% in constant currency, significantly ahead of expectations, primarily due to the strong renewal execution with higher in-period revenue recognition noted earlier. Search and news advertising revenue ex TAC increased 10% and 13% in constant currency, including 2 points from the Xandr acquisition. Results were driven by higher search volume with share gains again this quarter for our Edge browser globally and Bing in the U.S.”

“And in Gaming, revenue declined 4% and 1% in constant currency, ahead of expectations. Xbox hardware revenue declined 30% and 28% in constant currency on a high prior year comparable that benefited from increased console supply. Xbox content and services revenue increased 3% and 5% in constant currency, driven by better-than-expected monetization in third-party and first-party content and growth in Xbox Game Pass.”

Source: Company IR

Other notable comments from the earnings call:

Amy Hood said, “We will continue to invest in our cloud infrastructure, particularly AI-related spend as we scale with the growing demand, driven by customer transformation. And we expect the resulting revenue to grow over time. As always, we remain committed to aligning cost and revenue growth to deliver disciplined profitability. Therefore, while the scaled CapEx investments will impact COGS growth, we expect FY '24 operating expense growth to remain low.”And we expect the resulting revenue to grow over time. As always, we remain committed to aligning cost and revenue growth to deliver disciplined profitability. Therefore, while the scaled CapEx investments will impact COGS growth, we expect FY '24 operating expense growth to remain low.”

Satya Nadella put more thoughts on optimization and new workloads into an analyst question. “Thanks, Mark for the question. Maybe I'll make three comments. And it's also important, I think to distinguish between what I'd say, macro or absolute performance and relative performance because I think that's perhaps a good way to think about how we manage our business.”

“First is optimizations do continue. In fact, we are focused on it. We incent our people to help our customers with optimization because we believe in the long run that the best way to secure the loyalty and long-term contracts with customers when they know that they can count on a cloud provider like us to help them continuously optimize their workload. That's sort of the fundamental benefit of public cloud, and we are taking every opportunity to prove that out with customers in real time.”help our customers with optimization because we believe in the long run that the best way to secure the loyalty and long-term contracts with customers when they know that they can count on a cloud provider like us to help them continuously optimize their workload. That's sort of the fundamental benefit of public cloud, and we are taking every opportunity to prove that out with customers in real time.”

“The second thing I'd say is, we do have new workloads started because if you think about it, during the pandemic, it was all about new workloads and scaling workloads. But pre pandemic, there was a balance between optimizations and new workloads. So what we're seeing now is the new workloads start in addition to highly intense optimization driven that we have.”“The second thing I'd say is, we do have new workloads started because if you think about it, during the pandemic, it was all about new workloads and scaling workloads. But pre pandemic, there was a balance between optimizations and new workloads. So what we're seeing now is the new workloads start in addition to highly intense optimization driven that we have.”

“The third is perhaps more of a relative statement because of some of the work we've done in AI even in the last couple of quarters, we are now seeing conversations we never had, whether it's coming through you and just OpenAI's API, right? If you think about the consumer tech companies that are all spinning essentially Azure meters, because they have gone to open AI and are using their API. These were not customers of Azure at all.”These were not customers of Azure at all.”

“Second, even Azure OpenAI API customers are all new, and the workload conversations, whether it's B2C conversations in financial services or drug discovery on another side, these are all new workloads that we really were not in the game in the past, whereas we now are. So those are the three comments that I'd make, both in terms of absolute macro, but more importantly, I think, what is our relative market position and how it's being changed.”“Second, even Azure OpenAI API customers are all new, and the workload conversations, whether it's B2C conversations in financial services or drug discovery on another side, these are all new workloads that we really were not in the game in the past, whereas we now are. So those are the three comments that I'd make, both in terms of absolute macro, but more importantly, I think, what is our relative market position and how it's being changed.”

Amy Hood also added, “Mark, maybe the one thing I would add to those comments is, we've been through almost a year where that pivot that Satya talked about from we're starting tons of new workloads, and we'll call that the pandemic time, to this transition post, and we're coming to really the anniversary of that starting. And so to talk to your point, we're continuing to set optimization. But at some point, workloads just can't be optimized much further. And when you start to anniversary that, you do see that it gets a little bit easier in terms of the comps year-over-year. And so you even see that in a little bit of our guidance, some of that impact from a year-over-year basis.”we're continuing to set optimization. But at some point, workloads just can't be optimized much further. And when you start to anniversary that, you do see that it gets a little bit easier in terms of the comps year-over-year. And so you even see that in a little bit of our guidance, some of that impact from a year-over-year basis.”

Wall Street Analysts Notes:

Wedbush Securities analyst Dan Ives said in a research note. "It's clear that in Redmond's enterprise backyard the company is gaining more market share on the cloud front with many enterprises making this transformational shift on the shoulders of Microsoft,"gaining more market share on the cloud front with many enterprises making this transformational shift on the shoulders of Microsoft," He further said, "Cloud growth and the overall outlook for the June quarter was solid and much better than feared given recent noise in the market and will be music to the ears of investors this morning digesting results."Cloud growth and the overall outlook for the June quarter was solid and much better than feared given recent noise in the market and will be music to the ears of investors this morning digesting results."

BMO analyst Keith Bachman upgraded Microsoft (MSFT) shares to outperform. He stated that he now has "higher conviction" that any headwinds to Azure are likely to moderate by the end of the year, while opportunities in artificial intelligence can help the longer-term. "While the stock is not inexpensive, we think the durable growth opportunities warrant a premium valuation."

RBC Capital analyst Rishi Jaluria raised the firm's price target on Microsoft to $350 from $285 and keeps an Outperform rating on the shares. The company's "surprisingly clean" beat-and-raise quarter should help ease some concerns across software, including the narratives around cloud saturation, as AI is set to be the next frontier. Microsoft's commercial business showed more resiliency than expected, headlined by Azure growth hitting the high-end of guidance and Office 365 showing continued resiliency.

UBS analyst Karl Keirstead raised the firm's price target on Microsoft to $300 from $275 and keeps a Neutral rating on the shares. Microsoft's Q3 print was "surprisingly positive," with total constant currency revenue growth of 10% and a material EPS beat. The firm thinks the only concern might be the outlook for FY24 to be an AI investment year and what that means for gross margins and EPS growth.

Conclusion:

The company’s leadership position in the cloud and its perfect customer base of Fortune 500 companies have paid off. Even though Azure is decelerating what is important is that the company is gaining market share. Also, the opportunities in AI are the main highlights in the report, along with the company’s resilience in the Personal Computing Segment.

Recommended Readings:

https://io-fund.com/premium/microsoft-pre-er-will-we-see-evidence-of-a-bottom

https://io-fund.com/premium/google-faces-biggest-lawsuit-in-company-history-what-companies-could-benefit

https://io-fund.com/premium/microsoft-fyq2-guidance-weaker-than-expected

https://io-fund.com/premium/cloud-earnings-review-digging-deeper-on-best-of-breed

Microsoft Pre-ER: Will We See Evidence of a Bottom?

Posted on April 24, 2023June 30, 2026 by io-fund

Microsoft will report its Q3 FY23 results on April 25th. The company is one of the most anticipated earnings reports in determining cloud trends. The company’s overall revenue in Q2 was in line except for the personal computing miss (which was substantial, but is also well-known).

Azure posted slightly-better-than-expected growth of 38% compared to guidance of 37%. However, the Azure guidance for Q3 is for 30%-31% growth, which marks a sharp deceleration. The CFO also pulled fiscal year guidance, which is unusual for Microsoft. One key metric that could make or break Microsoft’s report will be if Azure has bottomed or if there is further decline.

What we are watching:

Revenue guidance for March quarter missed slightly by about $1.5 billion for a guide of $51 billion at the midpoint. This represents 3.3% growth compared to 6.7% growth expected. The guidance for the next quarter will be in focus.

Consumers are weaker than expected. Not only did More Personal Computing miss in Q2 but this segment is causing enough uncertainty that the CFO did not provide a fiscal year guide. Any insights in the earnings call are to be watched.

Azure guidance is at 30% to 31% growth for the March quarter down from 38% this quarter and down from 49% on CC basis in the year ago March quarter. We are keenly watching if Azure will bottom by not reporting sequential deceleration.

Customers exercised caution in the commercial cloud business. The company’s CFO Amy Hood said in the last earnings call. “In our commercial business, we delivered strong growth in line with our expectations. However, as you heard from Satya, we are seeing customers exercise caution in this environment and we saw results weaken through December. We saw moderated consumption growth in Azure and lower-than-expected growth in new business across the standalone Office 365, EMS and Windows commercial products that are sold outside the Microsoft 365 suite.”

Management comments in the commercial business are to be watched. The management in the previous earnings call provided guidance for the commercial business to grow 20% in the FY 23. They did not give a guidance in Q2 and instead said that revenue grew 20% in H1 and management expects it to further decelerate in H2.

Financials

Estimated Revenue:

Below, you can see that Microsoft is expected to bottom on growth. We talked about the H2 rebound in our most recent webinar. To some extent, the market is front running this rebound as anything can happen in the upcoming earnings reports. Regardless, Microsoft is a safer bet than others that revenue will rebound given its cloud suite drives down costs for enterprises.

· Q3 FY 23E (Mar 23): 3.41%

· Q4 FY23E (Jun 23): 5.82%

· Q1 FY24E (Sept 23): 9.09%

· Q2 FY24E (Dec 23): 10.44%

On a FY basis, Microsoft is expected to report the following – again, we are seeing evidence the next two quarters *should* be the bottom for Microsoft. We will want confirmation of this in the upcoming ER.

· FY June 2022 Actuals: 17.96%

· FY June 2023E: 5.37%

· FY June 2024E: 11.52%

· FY June 2025E: 13%

Microsoft has some of the strongest margins across the FAAMG stocks. For EPS, Microsoft is expected to report:

· Q2 FY 23 (Dec 22A): $2.20

· Q3 FY 23 (Mar 23E): $2.24

· Q4 FY23 (Jun 23E): $2.47

· Q1 FY24 (Sept 23E): $2.57

· Q2 FY24 (Dec 23E): $2.66

Cash Flow:

Cash flow was affected by the TCJA R&D tax payment of $2.355 billion. There is a new tax law that changes how R&D expenses are taxed, which you can read about here referred to as “Tax Cuts and Jobs Act” or “TCJA.”

Operating cash flow was $11.2B down (23%) year-over-year. Excluding the tax payment of $2.355 billion, Op Cash Flow was down (7%). Free cash flow of $4.9 billion was down (43%) YoY. Excluding the tax payment of $2.355 billion, FCF was down (16%).

Operating cash flow margin was 21.18% and adjusted excluding the tax payment was 25.65% compared to 28% in the same quarter last year. Free cash flow margin was 9.29% and adjusted excluding the tax payment was 13.75% compared to 16.65% in the same period last year.

For next quarter, the company expects to make a TCJA R&D tax payment of $1.2 billion.

The company returned $9.7 billion to shareholders with $4.6 billion in share repurchases and $5.1 billion in dividends. The company had cash and investments of $99.51 billion and debt of $48.12 billion at the end of the December quarter.

Noteworthy:

The management had highlighted in the last earnings call that the company is well positioned to capture the opportunity in AI. Satya Nadella said, “We have the most powerful AI supercomputing infrastructure in the cloud. It’s being used by customers and partners like OpenAI to train state-of-the-art models and services, including ChatGPT.”

We had written about the company’s dominance in AI before Chat-GPT3 was released and the market was buzzing about AI. We had said in our premium article in October last year, “Microsoft is a sleeping AI/ML giant. Google gets a lot of attention here yet I think they are equally prepared to serve this market. Maybe Microsoft even more so because of its penetration in the Fortune 500, which are the companies most likely to invest in AI/ML for the practical reason it requires a certain size budget.”

“To help Microsoft rival Google and DeepMind, the company has been investing in OpenAI, which is a large R&D operation that is breaking ground with AI algorithms that help computers to create images from text, reduce the amount of code that developers need to write, and to also help robotics think and act like humans, among other things. GPT-3 is the language generation model that has gotten quite a bit of attention for its ability to build websites and games using a language like English rather than a programming language. As of now, GPT-3 is known as the advanced text autocomplete program.”

Margins:

The Q2 one-time charge related to layoffs negatively impacted gross margin by $152 million, operating income by $1.2 billion, and earnings per share by $0.12. We would like to see consistency in the margins.

· Gross margin of 67% which was in line and flat YoY. The management guidance for the next quarter is 69%.

· GAAP operating margin of 38.8% and adjusted operating margin of 41% compared to GAAP OM of 43% in the year ago quarter. The management guidance for the next quarter is 40%.

Microsoft is looking to maintain the bottom line despite the weakness in consumer. The company’s CFO said in the last earnings call, “As a result, when excluding the Q2 charge and favorable impact from the change in accounting estimate, we expect full year operating margins to be down roughly 1 point in constant currency and roughly 2 points in USD, even with the headwinds from materially lower OEM revenue and higher energy costs.”

According to the preliminary results by IDC, there was a YoY decline of (29%) in the shipments of traditional PCs in Q1 2023 due to weaker demand and excess inventory. IDC expects growth after 2023. So, we expect that the Personal Computing Segment will be weak in the March quarter. Below is the management guidance for the various segments in the next quarter:

· Productivity and Business Processes is 8% YoY at the mid-point. (11% to 13% YoY in CC).

· Intelligent Cloud is 14.7% YoY at the mid-point. (17% to 19% YoY in CC).

· More Personal Computing a YoY decline of (16.7%) at the mid-point.

· Microsoft Azure is 30% to 31% YoY growth in CC.

We believe that there are chances for Microsoft to bottom first in Cloud before AWS or Google Cloud since Microsoft aggregate cloud services help to drive down costs. This is especially attractive for the Fortune 500 whereas startups, SMBs and mid-sized enterprises are likely to seek out and manage a larger portfolio of cloud services from various vendors. We can easily evidence this by Microsoft’s Fortune 500 penetration with 95% using Azure, which was achieved through hybrid computing where Microsoft was first-to-market on serving a mix of on-premise, private and public clouds for their large enterprise customers. Microsoft is a hybrid cloud leader which attracts large enterprises and its ability to reduce costs with its tech stack.

Recent Headlines and updates:

The company announced last month that the new AI-powered Bing and Edge has a good response. The company crossed 100 million daily active users of Bing. “Of the millions of active users of the new Bing preview, it’s great to see that roughly one third are new to Bing. We see this appeal of the new Bing as a validation of our view that search is due for a reinvention and of the unique value proposition of combining Search + Answers + Chat + Creation in one experience.”that roughly one third are new to Bing. We see this appeal of the new Bing as a validation of our view that search is due for a reinvention and of the unique value proposition of combining Search + Answers + Chat + Creation in one experience.”

The company introduced Microsoft 365 Copilot last month. It is the productivity tool that combines large language models (LLMs) with the data in Microsoft Graph and Microsoft 365 apps. The use cases of Copilot in Word include giving the users the first draft while saving the time on sourcing, writing, and editing the content. Similarly, Copilot in PowerPoint will help to create presentations based on the previous content. Copilot in Excel can analyze trends from the data, create charts, and helps to make informative decisions.

The company announced in February that is has previewed two AI-powered services that are designed to manage telecom networks. Jason Zander, executive vice president of strategic missions and technologies at Microsoft said, “What we’re doing is taking our native cloud work and making it specific to this telecom operator network space. I think a really great example of that is all the AI ops work that we are introducing into the system."

The company showed a demo to ad agencies on how the company plans to monetise the new Bing search. One of the ad executive noted, “The company said it is taking traditional search ads, in which brands pay to have their websites or products appear on search results for keywords related to their business, and inserting them into responses generated by the Bing chatbot.”

The UK’s Competition and Markets Authority after receiving feedback from industry participants have dropped some of the key concerns in the Microsoft and Activision deal. The CMA is expected to make a final decision on April 26.

What Analysts are Saying/Channel Checks:

Wedbush analyst Daniel Ives raised the firm's price target on Microsoft to $315 from $290 and keeps an Outperform rating on the shares. The firm's recent checks have been positive around overall cloud deal flow and momentum for Microsoft in the quarter and thinks the company should see at least low 30% Azure growth. He also believes that Microsoft could be in a position to take market share from Amazon AWS over the next 12 to 18 months. “There have been spots of softness, particularly in the financial space, but federal deals look to be strengthening, as Amazon (AMZN), Google (GOOG) (GOOGL), Oracle (ORCL) and IBM (IBM) have also seen a surge of Beltway cloud deal activity this year as the federal government enacts a major shift to the cloud.” Wedbush believes ChatGPT will be the next gear of growth for Microsoft over the coming years. The analyst further said, "We continue to believe the first step for MSFT was Azure/Office 365 with the next step ChatGPT/AI monetization on both the consumer and enterprise fronts combined adding $20 per share to MSFT's sum-of-the parts valuation as this execution story plays out,"

UBS analyst Karl Keirstead lowered the firm's growth estimates for Microsoft's Azure cloud segment, saying that recent trends have continued into Q1. The analyst, who made no change to the firm's Neutral rating or $275 price target, feels the Street's estimates for Azure are too high and concludes that customer efforts to optimize/trim their cloud spend will be deeper and last longer than most think based on calls with AWS/Azure customers and partners. UBS contends that the potential for a worse-than-Street-consensus Azure growth outlook creates some downside risk into the print.

Morgan Stanley says the firm's most recent CIO survey points to stable IT spending and suggests "favorable Microsoft-specific fundamentals." The firm sees several forward looking indicators in the CIO survey that support Microsoft's "strong relative positioning" if 2023 budgets come under further pressure, noting that Microsoft widened its substantial lead in expected IT wallet share gains. The firm, which calls Microsoft "increasingly well positioned" based on its survey work, has an Overweight rating and $307 price target on the shares.

Oppenheimer analyst Timothy Horan raised the firm's price target on Microsoft to $310 from $280 and keeps an Outperform rating on the shares. With the company now having introduced AI Co-Pilot betas across all Office, Cloud, and PC segments, the firm's initial estimate is approximately 3-5 points of incremental annual revenue growth ramping in 2025. This estimate balances the transformative nature of GPTAI, Microsoft's relationship with OpenAI, and large synergy opportunities as Microsoft has purposely understated pricing to spur early adoption.

Slowdown In Cloud Stocks On Thin Ice Following Q1 Guides

Posted on March 29, 2023June 30, 2026 by io-fund

This article was originally published on Forbes on Mar 23, 2023,09:56pm EDTForbes Forbes on Mar 23, 2023,09:56pm EDT

Following last quarter’s earnings, we published an analysis on cloud that showed hyperscalers were slowing (5%) sequentially and best-of-breed was slowing (12%) sequentially, based on Q4 guides.

What was most important for tech investors to realize, is that this is out of character for cloud, as Q4 is typically the strongest quarter. We concluded that this foreshadows a weaker-than-expected Q1 and also a weaker FY2023 than was currently baked into estimates.

Following the most recent earnings reports, our prediction is playing out that the slowdown we had predicted would worsen after the current quarter results.

This is important because the cloud category has treated investors quite well with recurring revenue, resiliency during Covid, and some of the strongest examples of product-market fit available on the public markets. However, not even this can overcome the effects of lower budgets and cloud spend, which is the top driver in terms of year-over-year comparisons.

Below, we discuss the fundamental weakness apparent in the most recent earnings reports. For our Premium Research Members, we are extending the analysis next week to include a few outliers that seem more resilient than others in the category, and those that are definitively the weakest.

Often times, identifying one or two strong companies in a category and patiently waiting can pay off, as the cloud category will put downward pressure on the stock price, including the outliers. Our goal is to buy the outlier(s) after they’ve been unduly penalized.

Sign up for I/O Fund's free newsletter with gains of up to 221% – Click hereSign up for I/O Fund's free newsletter with gains of up to 221% – Click hereClick here

Big Tech: Bellwethers for Cloud Spend

Big Tech competes with best-of-breed cloud companies in nearly every capacity. For example, although most think of Azure when looking at Microsoft’s earnings reports, the company has a formidable presence in cybersecurity worth over $20 billion in revenue. Google’s BigQuery is one of Snowflake’s largest competitors, as is Amazon’s RedShift. I covered the differences between the three for Forbes here.

We also made the following point about why the Big 3 is an important proxy in our analysis: “Slowing Growth in Cloud Stocks: When Will We Hit a Bottom”

“The Big 3 are the best proxy because their reports represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services. The Big 3 also afford a more concentrated view by owning 66% of market share across three companies whereas SaaS is spread across thousands of companies.”

The slowdown over the past four quarters is quite visible:

The Cloud slowdown over the past four quarters is quite visible – I/O FUND

The Cloud slowdown over the past four quarters – COMPANY RESULTS

Key Highlights from the Cloud Hyperscalers:

AWS:

AWS sales grew by 20% YoY to $21.4 billion in Q4, down from 27% YoY growth reported in Q3 and down from 33% YoY reported in Q2
Q4 2022 growth rate of 20% was halved as AWS sales grew by 40% YoY in Q4 2021
AWS revenue also missed the management guidance of 25% growth
Guidance for Q1 was not provided, however, it was stated the YoY growth rates in January were “in the mid-teens”

Azure:

Microsoft Azure revenue grew by 31% YoY and was down from 35% in Q3. In constant currency, it grew 38% and beat the management guidance by 1%.
Microsoft Azure revenue grew by 46% YoY and also in CC basis in Q4 2021.
The management provided guidance of 30% to 31% growth rate for the March quarter, down from 38% this quarter and down from 49% on a CC basis in the year ago March quarter.
You may recall the 5-point deceleration announced in the October report caused concern in the market. This is technically a steeper deceleration.

GCP:

Google Cloud revenue grew by 32% YoY to $7.3 billion and was down from 38% growth in Q3. Revenue missed the analyst consensus estimates by 1.5%.
The growth rate was also significantly lower than last year’s growth (down about 1/3rd) when Google Cloud revenue grew by 45% YoY in Q4 2021.

What Big 3 Management Teams are Saying

When there’s evidence of a deceleration, analysts will typically ask the management teams to elaborate on the call with the idea of identifying how much more deceleration may be reported in the future and for how long.

Here’s a question regarding AWS’s slowdown:

Mark Mahaney

[…] Brian, just any color on why mid-teens is kind of a holdable growth rate for AWS over the next couple of quarters, given what looks like pretty clearly, continuing deterioration in enterprise demand?

Brian Olsavsky (CFO)

So on the AWS growth rate, I'm not sure I can forecast for you with any level of certainty what is going to happen beyond this quarter. You kind of — this is a bit uncharted territories economically. And as we mentioned, there's some unique things going on with the customer base that I think many in this industry are all seeing the same thing.

[..] And whether there's short term, perhaps short-term belt tightening in the infrastructure expense by a lot of companies, I think the long-term trends are still there. And I think the quickest way to save money is to get to the cloud, quite frankly.”

Amazon’s management also volunteered the following in their opening remarks:

“Starting back in the middle of the third quarter of 2022, we saw our year-over-year growth rates slow as enterprises of all sizes evaluated ways to optimize their cloud spending in response to the tough macroeconomic conditions. As expected, these optimization efforts continued into the fourth quarter.”

They expect the optimization efforts to continue at least for the next couple of quarters and, in the absence of proper guidance for Q1, said that the YoY growth rates in January were in the mid-teens.”

Per management: “As we look ahead, we expect these optimization efforts will continue to be a headwind to AWS growth in at least the next couple of quarters. So far in the first month of the year, AWS year-over-year revenue growth is in the mid-teens.”

Here’s what Microsoft’s CEO, Satya Nadella, said in the first part of his opening comments:

“As I meet with customers and partners, a few things are increasingly clear. Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them optimize that spend. Also, organizations are exercising caution given the macroeconomic uncertainty.”

Later in the call the CFO mentions, “As noted earlier, growth continued to moderate, particularly in December, and we exited the quarter with Azure constant currency growth in the mid-30s.”

The I/O Fund has launched a new $99/year Premium Newsletter called "Essentials" — this newsletter delivers premium samples for our readers who want more actionable analysis for their tech portfolios. This month, we released a stock pick that we believe will be a leader in 2023 plus a video with the buy plan.$99/year Premium Newsletter$99/year Premium Newsletter called "Essentials" — this newsletter delivers premium samples for our readers who want more actionable analysis for their tech portfolios. This month, we released a stock pick that we believe will be a leader in 2023 plus a video with the buy planbuy plan.

My Translation:

Cloud will see belt tightening in 2023 and investors will have to gamble on the timing for when this turns around. It could be in the next few quarters or it could take years. Most of this will depend on the economy, as the common denominator for cloud stocks is budgets.

To be clear, the category has the potential to be quite resilient, which we covered in 2019 when we said, “My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Lastly, cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech — such as mobile, e-commerce and advertising — which are reaching saturation, are finding themselves in the cross hairs of anti-trust and are susceptible to consumer spending changes.”

There are a lot of cloud software bulls and for good reason, this category has treated investors well with predictable revenue growth. Cloud software is resilient because it drives down costs and increases productivity. We know this scenario well as we wrote about it many times in the past few years to defend cloud. Often, cloud selloffs were welcomed to position for a 6-month bounce back after the category sold off (40%) or more. I pointed this out in the past on the free side and here on MarketWatch (behind paywall) in 2019 (i.e., when we weren’t facing a brick wall on growth).

The issue with this assumption is that Cloud growth is actually slowing downCloud growth is actually slowing down —- that is the reality of things —- and this wasn’t true in 2019 and hasn’t been true in the last decade. Couple this with weak bottom lines that require cash injections, and what get is a sector that is largely out of favor.

What Analysts are Saying about the Big 3

Institutional analysts are able to do channel checks. It doesn’t hurt to see if there is more information available directly from large cloud customers.

Here are some recent analyst notes:

BMO Capital analyst Keith Bachman said until Azure growth stabilizes, the shares are likely to be range bound. The firm believes there is too much remaining uncertainty on Azure, which represents about 31% of BMO's revenue estimates.

Piper Sandler analyst Thomas Champion said that the Alphabet’s Q4 revenue and EBITDA missed across the board with advertising trends slightly weaker than expected, driven especially by Network. Search growth also slowed and Cloud growth decelerated 550 basis points. He further said Alphabet is transitioning the cost base for slower growth.

Piper Sandler analyst said that the Amazon’s Q4 results were mostly positive with revenues topping the high end of the guidance range. However, Amazon's guidance was slightly weak as Consumers sound cautious and the Cloud deceleration cadence appears to be landing in the mid-teens for Q1. The analyst believes management comments suggest the company is still navigating a difficult stretch.

Interesting enough, Dan Ives lowered his price target on Microsoft following earnings, yet has raised the price target again recently stating:

[…] [Wedbush is] "seeing steady cloud enterprise spending for Microsoft that has stabilized from the softness we saw in the month of December." Wedbush added that Microsoft, along with cloud competitors such as Amazon (AMZN), Google (GOOG), Oracle (ORCL), and IBM (IBM), are "seeing a surge of Beltway cloud deal activity in 2023 with a major shift to cloud underway from the Pentagon to civil agencies in the 202 area code."

More on Best-of-Breed

To help illustrate how the deceleration is quite steep for some best-of-breed names, we took a sample of the top-ranking cloud stocks on revenue growth, free cash flow, adjusted operating margin and/or valuations.

Among the best-of-breed cloud stocks, only ServiceNow’s guide shows sequential growth. The company’s QoQ growth was 7% last year and is expected to be 8% this year. The largest deceleration was in GitLab, with revenue that grew 12% QoQ last year, is expected to decline (4%) sequentially this year.

Overall, the category is slowing down sequentially (a rather drastic) 83% for Q1 guides compared to the previous year — from an average of 12% QoQ last year to 2% QoQ growth this year.

As stated in our previous analysis, it’s assumed that H1 2022 was strong so YoY is less important than QoQ/YoY. This is because the cloud slowdown happened later in the market cycle with first management comments appearing in Q3.

For example, best-of-breed cloud reported a 71% slowdown in QoQ/YoY growth for Q4 guides and is now guiding for a 83% slowdown in QoQ/YoY growth for Q1 guides.

Best-of-breed cloud reported a 71% slowdown in QoQ/YoY growth for Q4 guides and is now guiding for a 83% slowdown in QoQ/YoY growth for Q1 guides. – YCHARTS

Here is how this compares to last quarter when we were seeing a 2/3 slowdown from 17% to 5% when I stated:

“Yet, the Q4 guidance is out of character as we see a 2/3 decline in average sequential growth rate from 17% to 5%. This is the more severe drop off because Q4 2021 was much better than Q2 2022 in terms of the economy. However, my contention is that Q4 could be reflecting what is to come in 2023 rather a reflection of budgets from 2022 as the slowdown is more pronounced in Q4 than it has been in previous quarters from 2022.”

Source: YCHARTS

Conclusion

Below is cloud’s price action since we last covered the weakness in this sector. This is despite a surprisingly strong January and February for tech.

Above is cloud’s price action since we last covered the weakness in this sector. This is despite a surprisingly strong January and February for tech. – YCHARTS

Both Bill.com and GitLab saw weak price action compared to the others, and coincidentally, both saw sequential growth turn negative. Prior to the current earnings reports, I spoke about Bill.com and GitLab specifically with Samuel Burke of Real Vision when I forecast there would be further weakness in this category.

Many cloud stocks are on thin ice in this regard, and I imagine that if/when more cloud stocks turn negative on a QoQ/YoY basis compared to last year, weak price action will follow.

Source: Beth Kindig speaks with Real Vision about the cloud slowdown – REAL VISIONBeth Kindig speaks with Real Vision about the cloud slowdown – REAL VISION

Every investor must determine their personal risk tolerance. The I/O Fund noticed unusually weak fundamentals in cloud in Q3 and re-allocated our positions to other sectors within tech at that time. However, we are hard at work in determining the one or two cloud positions we’d like to buy when this category reaches a bottom. We share our stock picks plus entries and exits with our premium members. You can learn more here.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Microsoft FYQ2: Guidance Weaker than Expected

Posted on January 24, 2023June 30, 2026 by io-fund

Microsoft was up 5% after hours yet this reversed due to comments on the earnings call.

Ultimately, the guidance on the earnings call was weaker than expected in a few key areas:

Revenue growth for the March quarter had a slight miss.
Intelligent Cloud for next quarter is marking a 6-point deceleration sequentially and a 10-point deceleration YoY.
Azure is contributing to the deceleration in Intelligent Cloud with a 4-5 point deceleration sequentially from the exit rate in December (see below transcript for clarification from CFO). This puts Azure at 30% to 31% growth for the March quarter down from 38% this quarter and down from 49% on CC basis in the year ago March quarter. You may recall, the 5 point deceleration announced in the October report caused concern in the market. This is technically a steeper decel – comments from CFO clarifying this are below.
Commercial Cloud growth guidance of 20% for Fiscal Year 2023 (provided on last two calls) was essentially pulled and CFO said would decelerate in H2. Overall FY2023 guidance was not provided, which is out of character for MSFT. CFO cited it was due to consumer.
The consumer is weaker than expected. Not only did More Personal Computing miss this quarter but this segment is causing enough uncertainty that the CFO did not provide a fiscal year guide.

FINANCIALS:

The current quarter was in line across the board — except the Personal Computing miss – which led to a slight miss on the top line. Azure posted slightly-better-than-expected growth of 38% compared to guidance of 37%. GAAP EPS missed while adjusted EPS beat. FCF was down quite a bit from the previous year FQ2 due to one-time expenses and consumer weakness. We break the one-time expenses down below.

Microsoft reported revenue of $52.7 billion, which missed estimates of $53.2B or by about $500 million. The market overlooked this initially because the miss was driven by the PC/consumer segment whereas Intelligent Cloud beat. Notably, the revenue this quarter was in line with guidance from management.

The guide on revenue came in at $51B at the midpoint and $51.5B at the high end of guidance, which missed expectations of $52.6B or by about $1.5 billion. This represents 3.3% growth compared to 6.7% growth expected.

As noted, the full year guide was essentially pulled as the CFO did not state a FY2023 guide despite giving us one in the past two quarters. The understanding is that the full year revenue would “grow double digits.”

Here is what was stated on the earnings call in the previous quarter:

"At the total company level, we continue to expect double-digit revenue and operating income growth on a constant currency basis. Revenue will be driven by around 20% constant currency growth in our commercial business, driven by strong demand for our Microsoft cloud offerings. That growth will be partially offset by the increased declines we now see in the PC market.”

This was shared in the earnings call this evening but is pretty vague: “First, in our Commercial business, revenue grew 20% on a constant currency basis in H1. However, we now expect to see a deceleration in H2, given how we exited December.”

Below, I include more information from the transcript. However, the Commercial business decelerating in H2 indicates it’s not only consumer weighing on the full year guide.

The company reported GAAP EPS of $2.20 which missed estimates of GAAP EPS $2.28 – I believe this is due to the layoffs which had a $0.12 EPS impact. The adjusted EPS was in line at $2.32.

For the current quarter, the operating margin and net margin was weaker than last year although the CFO did reiterate the FY2023 operating margin would be down (1%) YoY. Here is what was stated:

“As a result, when excluding the Q2 charge and favorable impact from the change in accounting estimate, we expect full year operating margins to be down roughly 1 point in constant currency and roughly 2 points in USD, even with the headwinds from materially lower OEM revenue and higher energy costs.” Note: this is a pretty strong OM given the weakness in consumer implying Microsoft is very good at pulling the necessary levers to maintain bottom line strength.

The Q2 one-time charge related to layoffs negatively impacted gross margin by $152 million, operating income by $1.2 billion, and earnings per share by $0.12. Per our Pre-ER write-up, analysts are modeling annualized net of $2 billion per year from the layoffs moving forward.

There is also a new tax law that changes how R&D expenses are taxed, which you can read about here referred to as “Tax Cuts and Jobs Act” or “TCJA.” This tax payment was $2.35 billion.

In addition to these one-time headwinds, the segment weighing on operating income is the More Personal Computing segment down roughly 50% in Op Income whereas both Intelligent Cloud and Productivity grew double digits or more on Op Income (on a CC basis).

Gross margin of 67% which was in line and flat YoY. On a CC basis, gross profit grew 8% YoY to $35.3 billion.
GAAP operating margin of 38.8% and adjusted operating margin of 41% compared to GAAP OM of 43% in the year ago quarter. On a CC basis, the operating profit was flat with 0% growth for $20.4 billion in Op Income.
Net margin of 31.1% compared to 36% net margin in the year ago quarter. On a CC basis, net profit was down (4%) year-over-year for $16.4B in net profit which resulted in GAAP EPS being down (3%) on a CC basis.

Cash Flow:

Cash flow was also affected by the TCJA R&D tax payment. Operating cash flow was $11.2B down (23%) year-over-year. Excluding the tax payment of $2.355 billion, Op Cash Flow was down (7%).

Free cash flow of $4.9 billion was down (43%) YoY. Excluding the tax payment of $2.355 billion, FCF was down (16%).

For next quarter, the company expects to make a TCJA R&D tax payment of $1.2 billion.

The company returned $9.7B to shareholders with $4.6B in share repurchases and $5.1B in dividends.

Earnings Call:

Below is one of the most important questions on the call as the analyst Karl K. got three important things out of the CFO: (1) the rate of deceleration in Azure as it was not clear from comment she made as to whether it’s based on the 38% FQ2 number or the 35% December exit rate number. (2) The question also got the CFO to admit they did not give FY2023 guidance and (3) it allowed the CFO to reiterate the operating margin would remain consistent even with consumer weakness.

Karl Keirstead

Thank you. This one for Amy. Amy, given the obviously tough environment, it sounds like reaching that full fiscal year 20% constant currency commercial revs guide would be tough. Is that also true for the soft guidance for 10%-plus total revenue growth for the year? And if I could just sneak in a clarification, Amy, just because it’s an important metric. When you talk about a 4-point to 5-point decel in Azure, that’s off of the 38% reported for December, right, not off the 35% exit rate? Thank you.

Amy Hood

It’s all – Karl, let me just – the first half of your question, give me a second. On the second half of your question, which is the guide of the exit rate – it’s off the exit rate on Azure of four points to five points, just to make sure that is clear. In terms of thinking about total year revenue, right, I did not comment on full year revenue as we continue, I think really just to watch the Windows PC market as it returns to pre-pandemic levels. Outside of that, as you can see, the trends are relatively consistent. So, in some points, it’s important because if you look at the operating income margin guidance that I talked about, the fact that we are guiding to really only one point of margin deceleration for the year on a constant currency basis with probably over $2 billion of headwind from the OEM business from what we had anticipated heading into the year, the focus on margins, the focus on prioritization, the focus on putting our investments into where we know they have high return, I actually feel quite good about the place that puts us in as we exit the year in terms of – and the right energy, right, or leaving the year in Q4 on leverage.

Side Note: I’ve corrected my forum comments to reflect the 35% December number instead of the 38% FQ2 number. Azure coming in 8 points lower instead of 5 points lower sequentially is important to note. It looks like the analyst originally thought the decel was off the 38% as did I.

Another important question was around the strong trend toward optimization, or basically current customers looking for where they can cut costs. As you’ll see, some of this is from the Covid bloat although I would argue that consolidation is partly responsible, which happens to every major tech trend, regardless of a pandemic. Consolidation happens because demand for a trend is extraordinary in the beginning as excitement and adoption soars, and then consumers/enterprises cut back to only what is necessary. In the past decade alone, consolidation happened to ad-tech circa 2014, mobile apps and gaming. You’ll hear me talk about this a lot moving forward because I want I/O Fund members to be prepared – depending on how deep the recession is, not all cloud companies will survive. This is the very nature of tech.

Consolidation wasn’t specifically called out but I believe the optimizations happening now will result in consolidation and more M&A activity (if the weaker companies are lucky).

What the CEO is saying is that outside of the massive headwind that inflation presents for growth … that higher prices cause lower spending = vicious cycle that drives down growth … that he believes tech will eventually overcome this and become a larger part of GDP. In the meantime, this will be the year for optimization, and Microsoft will come out stronger in the long-term due to their positioning in AI.

Here is what was said on the call:

Brent Thill

Thanks. Satya, can you give us your overall macro view? There were some comments you had made that concerned, I think many about the state of the U.S. spending environment. I am just curious if you could comment and follow-up on what you are seeing there just from a spend environment throughout the year. I think many came away with that you are seeming that you were saying it’s getting worse, not better. Can you just give us a little more color on that? Thank you.

Satya Nadella

Thank you, Brent. And first of all, I was making a comment which was sort of a global comment, not just a specific U.S. comment. I mean there is only – I always sort of subscribe to that there is only one law of gravity that I think all of us are subject to, which is inflation-adjusted economic growth in the world. And then how many times that do we grow, because as I have said in my comments that I fundamentally believe tech as a percentage of GDP is going to be much higher and on a secular basis. So, the question is how many times is it given the overall inflation-adjusted economic growth. So, that’s kind of how I look at it. Given that, I think the two things that we see, we commented on that even in the last quarter, and it’s even in the outlook, which is the thing that customers are doing is what they accelerated during the pandemic. They are making sure that they are getting most value out of it or optimizing it and then also being a bit more cautious on given the macroeconomic headwinds out there in the market. So, given those two things, the point is at some point, the optimizations will end. In fact, the money that they save in any optimization of any workload is what their cloud into workloads. And those workloads will start ramping up. And so one of the key things we are watching for, Brent, is to make sure that we are gaining share in this space through our value propositions, so and even build loyalty with our customers so that long-term, we are well positioned for share gains. So, that’s sort of fundamentally how we view it. And then the other aspect I would also say is simultaneously investing in this new AI trend, because I don’t think any application start that happens next is going to look like the application starts of 2019 or 2020. They are all going to have considerations around how is my AI inference performance, cost, model is going to look like, and that’s where we are well positioned again. So, that’s how I view it. The market, you all are better readers of, quite frankly, what’s happening out there. We can tell you what we see. What we see is optimization and some cautious approach to new workloads and that will cycle through, but we do fundamentally believe on a long-term basis, as a percentage of GDP, tech spend is going to go up.

OpenAI was discussed on the call, and the CEO said what I would expect him to say – which is that Microsoft is strong in many areas of AI. For example, Github CoPilot offers auto complete coding suggestions and has 1 million users.

Conclusion:

We continue to like Microsoft for its bottom line and its ability to sell into enterprises. I believe this is the key thing missing in many of the other mega cap companies with AI/ML and other related ambitions, which is Microsoft owns the perfect customer base to ramp AI applications – which is the large budgets of the Fortune 500. Startups drive this too but not at the scale of the Fortune 500 and Fortune 2K.

We want to build this position on any weakness although we want to be sensitive to timing as we’ve been discussing for some time now that cloud budgets may be the next shoe to drop. The lack of a FY2023 guide from the cloud bellwether, although citing consumer, didn’t provide much information in terms of what the CY2023 cloud budgets are looking like. I think reading between the lines, even without a fiscal year guide, Azure’s further deceleration next quarter isn’t painting the best picture of cloud budgets.

On a side note, I am not sure what the tax implications of TCJA will be for other companies in the tech industry given the industry’s large R&D spending. After reading about the Tax Cuts and Jobs Act, it certainly doesn’t seem like it will be isolated to Microsoft and rather it will affect R&D investments primarily made outside the United States (foreign versus domestic R&D). Perhaps other Big Tech earnings next week will help shed some light on what to expect.

Microsoft FYQ2: Guidance Weaker than Expected

Posted on January 24, 2023June 30, 2026 by io-fund

Microsoft was up 5% after hours yet this reversed due to comments on the earnings call.

Ultimately, the guidance on the earnings call was weaker than expected in a few key areas:

Revenue growth for the March quarter had a slight miss.
Intelligent Cloud for next quarter is marking a 6-point deceleration sequentially and a 10-point deceleration YoY.
Azure is contributing to the deceleration in Intelligent Cloud with a 4-5 point deceleration sequentially from the exit rate in December (see below transcript for clarification from CFO). This puts Azure at 30% to 31% growth for the March quarter down from 38% this quarter and down from 49% on CC basis in the year ago March quarter. You may recall, the 5 point deceleration announced in the October report caused concern in the market. This is technically a steeper decel – comments from CFO clarifying this are below.
Commercial Cloud growth guidance of 20% for Fiscal Year 2023 (provided on last two calls) was essentially pulled and CFO said would decelerate in H2. Overall FY2023 guidance was not provided, which is out of character for MSFT. CFO cited it was due to consumer.
The consumer is weaker than expected. Not only did More Personal Computing miss this quarter but this segment is causing enough uncertainty that the CFO did not provide a fiscal year guide.

FINANCIALS:

Here is what was stated on the earnings call in the previous quarter:

Below, I include more information from the transcript. However, the Commercial business decelerating in H2 indicates it’s not only consumer weighing on the full year guide.

The company reported GAAP EPS of $2.20 which missed estimates of GAAP EPS $2.28 – I believe this is due to the layoffs which had a $0.12 EPS impact. The adjusted EPS was in line at $2.32.

For the current quarter, the operating margin and net margin was weaker than last year although the CFO did reiterate the FY2023 operating margin would be down (1%) YoY. Here is what was stated:

There is also a new tax law that changes how R&D expenses are taxed, which you can read about here referred to as “Tax Cuts and Jobs Act” or “TCJA.” This tax payment was $2.35 billion.

Gross margin of 67% which was in line and flat YoY. On a CC basis, gross profit grew 8% YoY to $35.3 billion.
GAAP operating margin of 38.8% and adjusted operating margin of 41% compared to GAAP OM of 43% in the year ago quarter. On a CC basis, the operating profit was flat with 0% growth for $20.4 billion in Op Income.
Net margin of 31.1% compared to 36% net margin in the year ago quarter. On a CC basis, net profit was down (4%) year-over-year for $16.4B in net profit which resulted in GAAP EPS being down (3%) on a CC basis.

Cash Flow:

Cash flow was also affected by the TCJA R&D tax payment. Operating cash flow was $11.2B down (23%) year-over-year. Excluding the tax payment of $2.355 billion, Op Cash Flow was down (7%).

Free cash flow of $4.9 billion was down (43%) YoY. Excluding the tax payment of $2.355 billion, FCF was down (16%).

For next quarter, the company expects to make a TCJA R&D tax payment of $1.2 billion.

The company returned $9.7B to shareholders with $4.6B in share repurchases and $5.1B in dividends.

Earnings Call:

Karl Keirstead

Amy Hood

Consolidation wasn’t specifically called out but I believe the optimizations happening now will result in consolidation and more M&A activity (if the weaker companies are lucky).

Here is what was said on the call:

Brent Thill

Satya Nadella

Conclusion: